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25/05/2015

Section 89 of the Income-tax Act

An employee’s tax liability can
increase when she receives arrears. However, one can get some amount of relief
under section 89 of the Income-tax Act, 1961. Here is a look at what is covered
under this section, and how one can avail of the relief.

WHAT IS SECTION 89?

The receipt of arrears can lead
to a higher tax incidence in the hands of the employee as the amount gets taxed
in the year of receipt. Had the employee received this amount in the year(s)
that it pertained to, the additional tax would have been staggered over the
years, instead of being paid as a lump sum. This is where section 89 comes in.

This section, titled “relief when
salary, etc., is paid in arrears or in advance”, comes under chapter VIII
(Rebates and Reliefs) of the income-tax Act. According to it, if you get salary
in arrears or advance in a financial year due to which your total income for
the year increases, which in turn increases your taxable income, you can claim
for relief under section 89. According to this section, arrears includes
salary/family pension paid in arrears/advance (additional salary), certain part
of gratuity, compensation received on termination of employment, and commuted
pension. The rules apply to both government and private sector employees.

HOW TO CLAIM RELIEF

Firstly, you should calculate tax
for the current year on income including the arrears or compensation. Then
calculate the tax for the current year on the income excluding the arrears.
After that, subtract these two figures; let us call this figure A. The next
step is to calculate tax for the year in which the arrears should have been
received—once with the arrears, and then without. Again subtract these two
figures; let us call this figure B.

To get the amount of relief that
you can receive under section 89, subtract figure A from figure B.

Here’s an example. Say, you earn
Rs.10 Lac a year in financial year (FY) 2014, and receive an arrear of Rs.4 Lac
for FY13. Your total salary in FY13 was Rs.8 Lac. For FY14, without the
arrears, your tax liability will be Rs.1.34 Lac, and with arrears (total salary
of Rs.14 Lac), it will become Rs.2.57 Lac. This is a difference of Rs.1.23 Lac.
Now, we have to calculate the tax incidence for FY13, on your salary of Rs.8 Lac.
Without the arrears, you paid a tax of Rs.92,700, and with the arrears (total
salary of Rs.12 Lac) you would have paid Rs.1.95 Lac as tax. This is a
difference of Rs.1.03 Lac. So, the relief that you can get under section 89 is
Rs.20,600 (Rs.1.23 Lac - Rs.1.03 Lac).

You will have to fill up Form10E
with these details and then submit it to your current employer to claim the
relief. Keep your salary slips handy to provide as proof of receipt of the
arrears. But do keep in mind that only if the tax paid is higher will you be
able to claim this relief. If you do not have to pay excess tax due to the
arrears, then you do not get the relief.